Budget 2023 Brings Fresh Challenges for Indian Startups: The Aftermath of Angel Tax

The Angel Tax has been a problem for the Indian startup ecosystem for many years. The tax, which was enacted in 2012 as an anti-abuse measure, was designed to stop the laundering of illicit funds by investing in unregistered businesses. However, it was incorrectly used over time to tax Indian startups’ capital raises as income. The only other country to tax capital gains as income was India. This stunted the development of the startup ecosystem there. To make matters worse for Indian business owners, the recently passed Budget 2023 included foreign investors in the Angel Tax’s purview. Given that a large portion of the funding raised by startups comes from foreign investors. This decision has caused considerable uncertainty and fear in the minds of Indian entrepreneurs.

Since these investments are now subject to the “Angel Tax,” many startups may be forced to relocate outside of India, further harming the ecosystem for Indian startups. The Indian startup ecosystem is still optimistic that the IMB process will undergo significant changes. Steps will be taken to prevent flipping, but until then, business owners must prepare for the current downturn. Capital raised from Alternative Investment Funds (AIFs) registered with SEBI and capital raised from foreign investors were the only sources exempt from this tax. Though, this exemption was removed in the most recent budget, placing startups in a precarious position. Angel tax has hung over Indian startups for years, and it seems like there is no end in sight.

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Startups lacked the funds to pay tax and were unable to raise capital as it would have gone toward paying angel tax liabilities. When the assessments for the tax came years after the capital raise. Indian entrepreneurs now feel a great deal of uncertainty and fear as a result of the recently passed Budget 2023. The already-stressed startup ecosystem now has to contend with the additional pressure of foreign investments being subject to the “Angel Tax. Startups must prepare for the current downturn and hold out hope that the IMB process will undergo significant reform soon. Along with action to put an end to flipping.

The Impact of Angel Tax Exemptions on Indian Startups

Angel Tax, a measure put in place to stop the laundering of black money through investments in unlisted companies, has long been applicable to startups in India. This tax has significantly impacted the startup ecosystem. As it frequently left startups with sizable tax liabilities that they were unable to cover. Government has made attempts in recently to exempt startups from Angel Tax, but it has its own set of limitations. The prohibition on salary advances, stock mergers and acquisitions (M&A), the formation of subsidiaries, and contributions to Employee Stock Option Plan (ESOP) trusts are some of the major restrictions. As a result, many startups have given up on this exemption and instead decided to relocate their corporate headquarters abroad.

The problem of “externalization” and how it is destroying the startup ecosystem has been acknowledged in the 2023 Economic Survey. It suggests actions like streamlining the Inter-Ministerial Board (IMB) certification procedure. To make sure that tax advantages are available to all Indian startups. Less than 1% of the 84,000+ startups currently registered with the Department for Promotion of Industry and Internal Trade (DPIIT) are IMB-registered.

It means that the majority of startups are unable to take advantage of the income tax benefits to which they are entitled. The absence of widespread tax advantages has also long been a problem for the gaming industry.

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This budget brought online gaming income under TDS with a minimum limit of INR 1. The government has not yet responded to other long-standing requests, such as the equalization of long-term capital gains on startups with listed securities and the rationalization of ESOP taxes. Restrictions of Angel Tax  has impacted negatively the startup ecosystem.

The Indian startup ecosystem is being negatively impacted by the restrictions that the Angel Tax Exemption currently imposes on startups. To address these problems and improve the environment for startups to thrive, the government must take significant action. Startups will still encounter difficulties navigating the intricate Indian tax system up until that point.